March 8 (Bloomberg) -- Amazon.com Inc.’s Web Services
division, whose server farms generate the processing power the
retailer sells to heavy corporate data users on the cheap, has
grown so large that the unit routinely finds itself with
thousands of spare machines.

So the e-commerce giant created a supply-and-demand-driven
market called Amazon EC2 Spot Instances that lets clients rent
processors for as little as 10 percent of Amazon’s standard
cloud-services fees. To use Spot Instances, companies bid for
the rights to a certain number of servers. Winning bidders are
billed by the hour, as long as the market price hasn’t risen
above an upper bound they specify.

The marketplace gives Seattle-based Amazon and its 7-year-old cloud-computing division an added advantage over Microsoft
Corp. and Google Inc., which are racing to catch up after a late
start. Analysts at Macquarie Securities estimated in a Jan. 7
report that total Amazon Web Services revenue will almost double
this year to $3.8 billion and will reach $8.8 billion by 2015.
Web Services will kick in close to 5 percent of sales this year,
up from 3.4 percent last year, and will rise to almost 8 percent
by 2015, Macquarie projected.

Were AWS a standalone company, it would be worth $24
billion, according to a March 5 report by Carlos Kirjner, an
analyst at Sanford C. Bernstein & Co. That’s more valuable than
two-thirds of the companies in Standard & Poor’s 500 Index, and
accounts for about a fifth of Amazon’s stock market value.

Analyzing Terabytes

Amazon’s lead in the public-cloud market, which Gartner
Inc. estimates jumped 20 percent last year to $109 billion,
poses a challenge for technology competitors. As an e-commerce
company, Amazon’s operating margins are already razor-thin -
-1.11 percent in 2012 -- while Google and Microsoft generated
margins last year of greater than 25 percent. That means Amazon
can cut prices on cloud services without affecting its total
profitability.

Investors aren’t fazed by Amazon’s low margins. The stock
trades at 186 times estimated earnings for this year, compared
with a ratio of 18 for Google and 10 for Microsoft.

Spot Instances was started in 2009, though the spot market
has taken off only in the past year, Amazon EC2 Vice President
Matt Garman said. Researchers in genomics and drug design as
well as online advertising increasingly use Spot to analyze
terabytes of data, while companies such as Cycle Computing LLC,
Princeton Consultants Inc., and Numerate Inc. have built
businesses that track market prices for heavy data users.

Spot Algorithms

“We’re finally starting to see the real change in the
slope of adoption,” Garman said. While he declined to provide
specifics on how profitable the product is or how many customers
use it, the company says much of its increased spending on
“technology and content” went to add capacity for Amazon Web
Services.

Princeton Consultants, a strategy and software firm, is
among the companies that developed algorithms to monitor Spot
Instances’ pricing and availability for clients in need of
server time. Chief Executive Officer Steve Sashihara said his
program, OptiSpotter, provides small hedge funds with the edge
they need to compete with investment banks and global funds in
the cutthroat world of high-frequency trading.

“It’s completely game-changing” for clients to cut a
project’s processing costs from $100,000 to $10,000 and get
supercomputer-like processing power, Sashihara said. “A couple
guys with $50 million can be trading at high frequency and be
taking on Goldman Sachs and Morgan Stanley.”

On Deadline

One big catch limits the utility of Spot Instances: If
rising demand sends prices skyward, a customer must outbid the
higher price to keep its project running. Otherwise, Amazon
shuts their servers off in midstream. That’s a deal-breaker for
clients using it to host websites or stream video.

Still, Crandell says he expects Spot Instances to keep
growing. As much as 15 percent of Amazon servers his customers
rent is now from Spot Instances, he says, up from the low single
digits in mid-2011.

Julie Black joined Web-advertising startup TellApart Inc.
in 2011 as director of engineering after six years at Google.
She uses Spot Instances regularly, because her former employer’s
recently introduced cloud platform, Google Compute Engine,
doesn’t offer a comparably cheap market. Burlingame, California-based TellApart analyzes online shoppers’ habits for retailers
such as Nordstrom Inc., One Kings Lane Inc., and CafePress Inc.

Faster, Cheaper

To provide better results than its dozens of competitors,
TellApart uses Spot Instances to collate more than 10,000
queries per second from hundreds of millions of people, with the
bulk of the work occurring during off-peak hours when prices are
lower. Black said the company, backed by almost $18 million from
venture investors including Greylock Partners and Bain Capital
Ventures, rents hundreds of machines at a time. Its monthly
check to Amazon is about 75 percent less than it would be for
cloud servers at the on-demand price.

“We process data faster and cheaper because we can use
more machines,” she said. “Everything we do relies upon this
core piece of technology.”